Lawyers Sue Stock Market for Being Rigged

On March 30, Michael Lewis went on "60 Minutes" and said that the stock market is "rigged." This past Friday, some plaintiffs' lawyers filed a lawsuit against, um, the stock market. This raises many questions, of which the most pressing is, what took so long? The lawsuit is basically just a synopsis of Lewis's book, "Flash Boys," and, I mean, how long can that take? I feel like plaintiffs' lawyers by now must have algorithms to transform news articles into lawsuits, so what was the holdup here?1

The other problem with the lawsuit is that it pretty much sues the stock market for being the stock market. So the defendants include pretty much every stock and options exchange,2
and also literally every brokerage, and literally every high-frequency trading firm. There's a long list of brokerages and HFT firms but:

The Brokerage Firm Defendants and HFT Defendants identified in ¶¶34-59 herein are sued both individually and as representatives of a defendant class (the "Defendant Class") consisting of all financial firms whose brokerage divisions placed bids or offers and/or transacted for members of the Plaintiff Class3
on stock exchanges and/or alternate trading venues during the Class Period; financial firms that operated alternate trading venues which provided venues for the anonymous placing of bids and offers and trading by brokers to the members of the Plaintiff Class during the Class Period; and financial firms that engaged in high frequency trading during the Class Period.

Plaintiff alleges, based on information and belief, that there are hundreds of members of the Defendant Class. The members of the Defendant Class are so numerous and geographically dispersed that joinder of all such Defendant Class members is impracticable.

So every brokerage firm that transacted for clients since April 2009 is (supposedly!) a defendant in this lawsuit, including just for instance noisy HFT critics Themis Trading. And everyone who "operated alternative trading venues which provided venues for the anonymous placing of bids and offers" is (supposedly!) a defendant, including just for instance Michael Lewis's heroes at IEX.

That should give you a sense of what utter nonsense this complaint is. It's (supposedly!) a class action, so it has to claim that "There are questions of law or fact common to the Defendant Class that predominate over any questions affecting only individual members," but that is obviously false; some trading venues do the stuff that the complaint complains about, and some don't, and you might naively think that would matter. It can't possibly be true that every brokerage firm in the country helps HFTs front-run investors, can it? Or that every trading venue is built around enabling predatory behavior, including ones like IEX designed to shut down that behavior?

The stuff the complaint complains about, by the way, is mostly just what's in "Flash Boys." Basically it's that high-speed traders trade faster than low-speed traders, via latency arbitrage or moving in reaction to orders in the market or co-location or direct data feeds or ... there's some weird stuff here, like an accusation that high-frequency traders trade in advance of index-fund rebalancing, which is just intelligently making use of public information but which these lawyers find objectionable.4

I don't get this case at all. Here is a reasoned discussion that asks "whether this case will get through to the point where there is a settlement or settlements," but I don't see it. The problems here are not about exchanges or brokerages or HFTs doing nefarious underhanded things that secretly deceived the investing public. The problems here, if they are problems, are structural. They're about exchange rules and Securities and Exchange Commission regulations that have created a market system that not everyone likes.

But that is the system that exists, and it seems unfair to blame everyone for operating within the system.5
So, for instance, brokerages look like bad guys for routing orders to the supposedly corrupt exchanges, but what were they supposed to do, not route orders anywhere? If you don't like the system created by modern market rules, then working to change those rules seems like a sensible solution. Suing everyone for following the existing rules seems like silly grandstanding.

It's easy to see the appeal of the view that equity markets are rigged. It explains why you can't make money trading! It's not that markets are efficient and therefore everyone's trading should on average be loss-making net of costs. It's that markets are rigged. If they weren't rigged you'd be making billions.

That understandable sense of frustration has several appropriate outlets. You could write a book, or talk to someone writing a book. You could lobby the SEC to try to get the rules changed. You could even start your own trading venue that would forbid the practices you don't like, and hope that others agree with you and come trade on your venue.

But this is America, and we have a long and proud tradition that holds that every frustration deserves a lawsuit. And this is about the lawsuit that HFT frustration deserves.

1
I want to believe that it took the law firm, Robbins Geller Rudman & Dowd LLP, a long time to find a plaintiff to sign on to such a silly lawsuit, but that probably can't be right. The named plaintiff is the City of Providence, Rhode Island.

3
Which in turn consists of "all public investors who purchased and/or sold shares of stock listed on a U.S.-based exchange or alternate trading venue between April 18, 2009 and the present and were injured thereby." So it would presumably include, among a zillion others, the HFT and brokerage defendants? I don't know.

4
Like:

Most retirement savings, such as public and private pension funds or 401(k) and individual retirement accounts in the United States, are invested in mutual funds, the most popular of which are index funds which periodically "rebalance" or adjust their portfolio to account for current prices and market capitalization of the underlying securities in the stock or other index that they track. This allows trading algorithms to anticipate and trade ahead of stock price movements caused by mutual fund rebalancing, making a profit on advance knowledge of the large institutional block orders. This results in profits being transferred from investors to algorithmic traders, estimated to be at least 21 to 28 basis points annually for S&P 500 index funds, and at least 38 to 77 basis points per year for Russell 2000 funds.

I do not get it. Index rebalancing is public information. If you have a computer that does the math and calculates that people will be buying a lot of stock on an index add, and you buy some of that stock to profit from that calculation -- what is illegal or fraudulent or whatever about that? This is not in the book, by the way; they came up with this on their own.

Even Katsuyama comes round to the HFT villains towards the end. “I hate them a lot less than before we started,” Lewis quotes him as saying. “This is not their fault. I think most of them have just rationalised that the market is creating the inefficiencies and they are just capitalising on them. Really, it’s brilliant what they have done.”

Indeed, as Lewis explains, much of their behaviour was perfectly in line with regulations – the Securities and Exchange Commission deliberately tried to weaken the monopoly power of large exchanges to create more competition.

To contact the writer of this article: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.

Matt Levine is a Bloomberg View columnist writing about Wall Street and the financial world. He is a former investment banker, mergers and acquisitions lawyer, and high school Latin teacher.
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